Health Economics

When trying to connect ‘health’ and ‘economics’, one usually thinks of (1) health being the most precious good. In order to remain in good health just about anything should be done; (2) health care being in a crisis. If the costs of health care were to continue to increase at the current rate, then health might become unaffordable to most people.

‘Life is priceless.’ Most people would probably agree with this statement. However, decisions affecting lives are not only made by individuals but (necessarily) also by parliaments and public authorities on a regular basis. This implies weighing up the preservation and lengthening of human life against the input of scarce resources (i.e., money). Examples for such decisions in the public sector can be found not only in health care but also in many other sectors, especially those related to transportation and the environment.

“Health is not everything in life, but without health, life is nothing”. This proverb points to the dual property of health. (1) Health is a highly valued asset. Sometimes it is even claimed that health is the only thing which counts in life. The first part of the proverb reminds us that other values and goals do exist in life, yet, compared with health, they rank lower on the preference scale of most people. While this priority of health is accepted as a fact in the following section, it does not rule out that health risks (i.e., an increased probability of poor health) are taken in order to achieve other goals.

The concept of a transformation curve for consumption services and health, introduced in the previous chapter, raises a number of questions which are of considerable importance for health policy. To illustrate this, consider the increase in life expectancy in industrialized countries (see Table 4.1).

The allocation of health goods frequently deviates from the principles of a market economy. This holds true particularly of medical services, even in Western industrialized countries, which claim to be market economies. In general, neither the decision to offer a medical service (e.g., an appendectomy) nor the decision to demand that service are made by sovereign individuals or firms who bear the full financial consequences of their choices.Moreover, the pricemechanismis not permitted to coordinate choices in health care by signaling varying degrees of scarcity. The decisionmaking process is thus completely different from that characterizing the production and purchase of refrigerators, for example.

In Chapter 5, several reasons were presented and discussed as to why a developed society may decide to have social health insurance with compulsory membership. This means that individuals are not completely free in deciding the amount of their insurance coverage against the cost of illness, since they are not permitted to have less than a minimum level of protection.

In the 1990s, several countries exposed their social health insurers to an increased degree of competition in the hope of improving efficiency in health insurance and in their health care sectors. However, as shown in Section 5.4, competitive health insurers tend to charge a high premium to high risks and a low premium to low risks. This is nothing but a generalized version of the ‘price equal to marginal cost’ rule; after all, high risks are characterized by comparatively high expected cost of treatment due to a high probability of being sick. Moreover, for reasons spelled out in Chapter 5, the government wants all citizens to have health insurance.

Private-practice physicians play a key role in the production and distribution of medical services.Most people first see a physician when they seek help for a health problem. This makes the physician the first agent to decide upon diagnosis, treatment, prescription of drugs, and referral to other providers of medical services (specialists, hospitals, pharmacists, and different types of therapists). Consequently, physicians are regarded by many as gatekeepers to the health care system.

In debates about the economic problems of health care, the hospital plays a key role. This is due to the quantitative importance of the hospital industry. In many industrialized countries, hospital services account for the largest single block of health care expenditure. In 2005, most OECD countries spend more than a third of health care expenditure on hospital services [see OECD (2008)].

One of the guiding themes of this book is the optimal design of incentives for patients and providers. In Chapter 6, we concentrated on the demand side. In case of moral hazard, we found that complete insurance coverage encourages excessive use of health care services by the insured. For this reason, demand-side cost sharing in the form of copayments will usually be optimal. In this chapter, we turn to the supply side to examine optimal incentives for providers of health care services who are prone to moral hazard as well. After all, they are guaranteed reimbursement regardless of cost by an insurer paying fee-for-service. Incentives to control costs under such a payment system are weak, calling for some kind of supply-side cost sharing.

Forms of delivery of medical care differ considerably between countries. These differences ultimately reflect basic differences of philosophy.Where the state grants the citizen a right to health, government tends to be directly responsible for the provision of health care services. Examples include the former eastern bloc countries as well as the United Kingdom and Italy with their National Health Services. Conversely, in the United States it is the individuals themselves who in principle assume responsibility for their health. Nonetheless, the public purse finances 40 percent of total U.S. health care expenditure (HCE), supports public hospitals, and acts directly as a health insurer through the programs Medicare (for pensioners) and Medicaid (for the poor). While there is no National Health Service in Canada, the country has a national health insurance scheme. In the Netherlands, more than 30 percent of the population were members of a private health insurance scheme before the 2006 reform. Since then, formerly public and private health insurers compete for consumers side by side. Swedish hospitals, financed by district health authorities, play a key role in the provision of medical care.

Whenever a normative statement was made in Chapters 5 to 12, it was based on the efficiency criteria of welfare economics. This left open the issue of whether a Pareto-optimal design of a health care system might ever be achieved. Therefore, this chapter raises the question of what determines the actual (rather than any desired) institutional structure of a health care system. This type of question is the topic of ‘Political Economy’, also known as ‘Public Choice’. This is a comparatively recent field of theoretical and empirical research into behavior in the political domain.¹ With regard to health policy and regulation, the following agents can be distinguished.

Actors on markets are under continuous pressure to adjust. Consumers’ changes in taste lead to changes in demand, new technologies provide rivals with competitive advantage, and public authorities step in to regulate or even prohibit business. This pressure to adjust is transmitted by price signals indicating to firms the need to adapt their goods and services to new circumstances. In health care, however, fluctuating market prices formedical services are incompatiblewith the key principal-agent relationship between the patient and the service provider because they might violate both the participation and the incentive compatibility constraints (see Chapter 11, Appendix). One possibility of avoiding fluctuating prices is bargaining over fee schedules, which paves the way for the important role of professional associations and public authorities in health care. The inflexibility of fees and prices is further enhanced by the fact that purchases of health care goods and services such as pharmaceuticals abroad are often legally prohibited. This serves to insulate domestic markets from international shocks but also competition.